The fiscal cliff deal

Short-term relief, and little else

AMERICA, it appears, will go over the fiscal cliff after all, but only for a few days. If all goes as planned, the worst of the cliff, a withering combination of tax increases and spending cuts, will be avoided, while the ugly fiscal arithmetic and political dysfunction that produced the cliff in the first place will remain.

A deal nearing completion in the Senate would make permanent the tax cuts first enacted by George Bush in 2001 and 2003 and due to expire on December 31st, except for the wealthy. The marginal rate for individuals earning more than $400,000 and couples earning more than $450,000 would rise from 35% to its pre-2001 rate of 39.6%, while deductions would be curbed for some people earning as little as $250,000. Estate taxes would go up, but not to pre-2001 levels, while rates on capital gains and dividends, now 15%, would go up to 20%, still less than their pre-2001 levels. Tax credits for families, workers and college students first introduced in Mr Obama’s stimulus plan will be extended for five more years.

Although passage in the Senate seemed certain, the bill's fate in the House is more of a wild card. Partisans on both sides hate the deal: liberal Democrats because it does not raise rates on everyone earning more than $250,000, as Mr Obama had long demanded; Republicans, because they are being asked to approve the first increase in tax rates in two decades while getting no spending cuts in return. (Update: the senate approved the agreement early Tuesday by a vote of 89 to 8. The house approved it late Tuesday 257 to 167, with 85 Republicans joining nearly all the Democrats.)

Nonetheless, both sides realised the alternative would be much worse. If the country entered January with no deal in sight, taxes would rise on the vast majority of households, a hit worth more than $300 billion, or 2% of GDP, per year. Since the House will not vote until January 1st at the earliest, taxes will rise, at least for a day. But most households will not notice because employers should be able to withhold taxes at the same level as last year by the time the first paychecks of January go out.

By avoiding that hit and finally nailing down numerous features of the tax code, the deal lifts a cloud that had hung over the economy and investor confidence. But on almost every other point, the deal falls short of already low expectations. It leaves in place significant short-term austerity while doing nothing to change the long-term trajectory of debt. It doesn't reform taxes or entitlements. And it doesn't deal with several key components of the cliff.

The main elements of the fiscal cliff were the expiring Bush tax cuts; expiring extended unemployment insurance benefits; an expiring payroll tax cut; automatic spending cuts worth $110 billion per year, spread equally across defence and domestic programmes (called a sequester); and the debt ceiling, the statutory limit on how much the Treasury must borrow, which was reached on Monday.

The current deal covers only the Bush tax cuts and enhanced unemployment-insurance benefits, which will continue for one more year. The payroll-tax cut will expire as scheduled, sapping workers’ purchasing power by roughly $1,000 each. Together with the higher taxes on the rich, that will impose a significant fiscal drag on the still-fragile recovery early in 2013.

The sequester was due to take effect this week. That will be delayed for a few months. The White House has discretion to backload some of the cuts for now, in hopes of a negotiated delay or replacement. But the Pentagon has already warned some of its 800,000 civilian employees of furloughs, and contractors who do business with the federal government may start to lay workers off.

Meanwhile, the Treasury can use various accounting manoeuvres for about two more months before it completely runs out of room to borrow without an increase in the debt ceiling. At that point, it will have to stop paying some bills—to Social Security (pension) beneficiaries, soldiers, Medicare doctors, and perhaps eventually bondholders, bringing on default.

Permanently replacing the sequester and raising the debt ceiling will require intensive new negotiations likely to begin as soon as the tax deal is signed into law. Yet the last few months have shown the two key players to be incapable of making those sorts of deals. It is telling that both Mr Obama and Mr Boehner were on the sidelines as the final deal was worked out between Mitch McConnell, the Republican minority leader in the senate, and Joe Biden, who in addition to being vice-president is a former senator.

Eight weeks ago, hopes ran high inside and outside Washington that Mr Obama and Mr Boehner could in fact strike a grand bargain: higher revenue in return for entitlement reform. Mr Boehner hoped to revive the deal he briefly entertained with Mr Obama in the summer of 2011 along just those lines. But Mr Obama, his hand strengthened both by re-election and the economy’s stronger footing, was less inclined to compromise, and focused instead on forcing Republicans to accept much higher taxes on the rich or pay a grievous political price for refusing. “It’s not acceptable to me, and I don’t think it’s acceptable to you, for just a handful of Republicans in Congress to hold middle-class tax cuts hostage simply because they don’t want tax rates on upper-income folks to go up,” he declared at a campaign-style event in late November, while his and Mr Boehner’s staff were trying to narrow their differences.

For his part, Mr Boehner never seemed sure of what his own members could accept, which made for unproductive negotiating sessions. He offered $800 billion in new tax revenue without apparently saying how the money would be raised. Democrats were willing to consider curbs on entitlements, as long as Republicans bore responsibility for putting them on the table. Mr Boehner seemed unwilling to accept that burden, instead haranguing Mr Obama for failing to specify his own entitlement cuts. Nor was it clear what Mr Boehner could deliver on taxes; his own bill to raise taxes on just millionaires had to be yanked because of insufficient Republican support. Rather than a sign of negotiating strength, it became a humiliating sign of his ineffectiveness.

Since the summer of 2011 Republicans have insisted on deep cuts to spending as the price of raising the ceiling, even if it means risking default. Some will be doubly determined to pursue that strategy now. They rightly complain that the deal does nothing to alter the long-term upward trajectory of the debt. Higher taxes on the rich will reportedly raise about $600 billion over a decade, an “inconsequential” sum, noted Bob Corker, a Republican senator. Indeed, it is almost a rounding error against a ten-year projected deficit of $10 trillion on current policies, or 5% of GDP. “The fact that the president won’t challenge his party on spending cuts is disgusting,” said Steven LaTourette, a Republican congressman.

While Republicans will try to use the sequester and debt-ceiling negotiations to secure the spending cuts that this week’s agreement omitted, Mr Obama signaled today he was equally determined that taxes have to rise further, too. “If Republicans think that I will finish the job of deficit reduction through spending cuts alone…they’ve got another thing coming,” he said in a brief public appearance Monday that riled Republicans with its partisan, combative tone. It may be that Mr Obama was mostly trying to reassure his own liberal base that it was the opposition, not him, who caved in this time. But it may also be a sign of the tone likely to prevail in coming months.

It's not dividends that need to have higher tax rates, it's net income. From the corpotate perspective, income is taxed whether it is distibuted or not. Taxing dividends alone would just discourage dividends, it wouldn't necessarily encourage reinvestment as companies could just let cash build up on their balance sheet.

Income tax rates need to be set at a level that causes the default financing decision to be to reinvest in the company, not distribute the income as a dividend or let cash pile up.

Of course for this idea to work long term capital gain tax rates should be lower than income tax rates. This also encourages long term investing. However, we probably need to revise long term investments to mean investments held for five years or more, instead of just one year.

Having lower long term capital gain tax rates also solves the problem you mentioned about making it more difficult to finance by issuing stock. If the stock can be sold 5 years down the line at a preferential tax rate, a company should have no real problems finding investors.

This "taxing the rich" talk is a red herring and not the issue, the issue is that people need to pay their fair share and we have people and corporations paying no taxes yet earning millions - that has to be fixed. Fair is fair and nobody should get something for nothing - we agree on that but when you make millions and pay no tax, you are getting something for nothing on the backs of someone else.

The health care system is a mess and so expensive for what we get and all so that self interested health care middlemen can take their cut to maintain their wealth and keep sick people poor. America ranks somewhere around 50th best healthcare system in the world behind many third world countries because the system is broken, expensive and out of reach for many people. Is paying twice as much for the same procedure as Canadians right? Where does all that money go and why can't there be a government run plan that bargains for health care services on our behalf. It will save everyone money on health care. And guess what, if people still want to pay twice as much from a private health care provider for the same services then they can still do it, it is a free country.

And don't knock Europeans, they have a better standard of living than Americans, they have good health care, they live longer, they have less gun violence and they are trying to implement a free trade system that will someday likely be the envy of America.

We agree on the military thing - why should Americans pay for every conflict the world has - let someone else take up the slack while America gets the finances in order.

Let's remember that this election was won on a promise of reduced military spending and increased taxes and lost on a promise of increased military spending and reduced taxes. The majority voted that way because they are aware of the critical fiscal problem in this country, that a deficit of 7.5% of GDP cannot be maintained for a sustained period of time. If nothing is done the debt servicing costs start to be larger than all other initiatives due to the size of the debt and the increased cost of borrowing. At that point the debt holders start to determine your interest rate and a lot of other things that the government should control and we lose control over the country.

A country is no different than a household, if you get too far into debt then you need to increase your earnings and decrease your spending in order to get back to a point where the debt payments only represent a small proportion of your monthly costs and at that point you can have a better standard of living again. The same is true for the government, they need to increase taxes and decrease spending to get the deficit to zero. When the surpluses start to come then it is OK to decrease taxes and increase spending. We have too many politicians who just want to protect their own self interests and are not interested in the long term health of this country.

I am sick of the partisan politics and all this talk about which party is responsible for all the woes of the country. The fact is that politicians need to come together and care more about their country than lining their own pockets. Let's take 5-10 years of short term pain and increase taxes while cutting expenditures, get to a zero deficit and then we can reap the benefits. If they cannot do that then let's toss out the uncooperative ones at the next election and get someone in there who will do the job. Everyone should pay close attention to what their house of representative is doing and has done for the last few years because they hold the power to legislate all of the monetary spending and taxation. Let's give power back to the people and only vote in the representatives that care more about the country than their own self interests, regardless of their political affiliation.

Expect a House Leadership challenge and Mr Boehner's replacement with a more intransigent Eric Cantor or the encumbent winning by pledging to hew to the Republican right's ideology with no "surrender." The Tea Party contingent believes it is carrying the torch of freedom and they are not going to let reality alter their convictions. They are blinded by their self-righteousness in a manner that has no real equivalent in the Democratic party. The best hope before the next round of congressional elections is a plan that can secure about 120 votes from each party in the House or one that most Democrats and a minority of Republicans can support, assuming the leadership would even allow such a plan to come to the floor in the latter case! That is a slender reed upon which to rest any hope of a real economic recovery.
This is no time for divided government but in 2012 that is what we got, even if the Republicans were bloodied. I hope the electorate learns this lesson in time for 2014. In the mean time I certainly hope Mr Obama becomes more partisan. Compromise requires interlocutors who are willing to make concessions and accept the fundamental legitimacy of their political opponents. With the Republican party in thrall to an ideologically fundamentalist base that cannot differentiate compromise from surrender, and who often have shown that they are unable to accept Mr Obama as an American citizen, negotiation is only a tactic to gain short term advantage. Expect the USA to veer from cliff to crumbling cliff for the next couple of years.

The US population had been forecasted to gradually rise through the century though.
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Have not heard of forecasts on aging for the US that resemble what is expected in Japan, South Korea or China.
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What is meant by Ponzi Scheme? I keep hearing that phrase brought up without any context, definition, explanation, etc. Please elaborate.

Also, do we really think that Biden was negotiating independently of Obama?

"It’s telling that both Mr Obama and Mr Boehner were on the sidelines as the final deal was worked out"

Boehner was on the sidelines because his Plan B gambit failed against the solidarity of the Tea Party, but there's no way he was completely out of picture on negotiations, since he'd need to deliver at least 100 or so GOP votes in the House. If Biden was anything more than a familiar face acting as a go-between, I'd be shocked. It makes no sense for the shift of principals to have been anything more than cosmetic.

i think America's conflicted over it's ideology of capitalism. Capitalism,like communism, or socialism is a means to an end, and as the ends keep changing, so should the US approach be.

US is a great nation with many strengths, and it has done loads of good for its' citizens as also the world. But unbridled corporate greed has crept into people and now ANY governments' legitimate actions (defense, social welfare and investment directions) are to be trimmed, so corporates can continue to enrich themselves even as the US citizens suffer - this cannot be an acceptable outcome to anyone with an iota of sense.

At a time when US HDI (healthcare and education are especially shocking) is near the bottom of OECD, corporates and the rich should be patriotic enough to chip in and save America, not demand their pound of flesh even more noisily.

Something quite not right about the way different interest groups are floating new theories to muddy the waters.

Do you have any evidence whatsoever of the things you are saying? You appear to know why people voted for Obama and what he thinks. Even a skilled psychologist might hesitate to give such definitive diagnoses without ever likely meeting the man.

This Republican House of ours seems to think that being as useless as possible will stick it to Obama. I cannot wait to see them realize their mistake come the next election.
Country before party should be the motto, every time.

Well Communism and Socialism had an "end" which was a classless, wealthy society. Socialism was a more evoluationary and pragmatic path, that possibly didn't see the complete disappperance of class.

I am not so sure capitalism does, other than eventually providing the greatest good for the greatest number of people (so maybe an utilitarian end). Of course Adam Smith wasn't against all goverment plans or programs, because he wasn't an anarchist.

Yeah the biggest problem here is "spending". Solving our governments debt is not rocket science. Set a budget and do not spend over the budget! How do you think people in the middle class gets by Mr. President? Why is this so hard? The article clearly points out that there are policies in place that need to be redone to have major change on the deficit. Taxing the rich is a public relations stunt by the Democrats to get more votes in the next election or other elections. Why else would the President and Democrats be wanting to tax the rich so much?

Raising taxes on the successful is not the answer. All this is doing is infuriating people. I do not work hard so someone else can collect a government check or go to the "worlds police", aka the american military. This is America people! Wake UP! Go to Europe if you want those who work hard paying for other peoples problems! Look how great Europe looks right now.

The deal presents a useful and pragmatic compromise intended to avoid the immediate problem of a self-imposed shot in the foot.

Having gotten beyond this problem (and the House will not ultimately fail to agree), the President will be met on January 3 by a new Congress, with 9 more Democrat Representatives and 2 more Democrat Senators. While still not an out-an-out majority, the ever-present log jam in Congress should be eased a bit by this change and should offer the President a more conducive partner in government.

This will be particularly true if Mr. Reid succeeds in amending the Senate's filibuster rules to crimp Mr. McConnell's neurotic penchant for denying consideration of virtually everything.

As to the so-called "Debt Ceiling", a careful reading of that statute at 31 U.S.C. 31.1.3100 shows that it is only "directory" and not "mandatory": It does not, actually, restrain the President and the Treasury from issuing new debt beyond any particular level, by which to cover the expenses mandated by Congress's legislative acts. Anyone who thinks otherwise is indeed going to be sorely surprised when Mr. Geithner (or successor) continues issuing new debt in order to avoid a crippling US default and cries "sue me" in Congress's tone-deaf ear. SCOTUS will likely uphold the directory nature of the statute, as well as the US 14th Amendment's imperative that the national debt not be placed in question, rather than hold with Congress's perogative to incite national disgrace and international financial calamity by repudiating the US national debt and the consequences thereof on the Treasury.

If the MAJORITY of tax filers pay NO NET FEDERAL INCOME TAX, then major spending cuts are politically IMPOSSIBLE! Most Americans are SPECTATORS not participants in FISCAL policy! Entrenched well organized constituencies like farmers, crony capitalists, Public Worker Unions, the Grey Hairs and the like have NO real counter force to cut their entitlements. That is why I STRONGLY FAVORED GOING OVER THE SO CALLED CLIFF! Reality would finally be forced on the MAJORITY that they had TO PAY FOR ALL THE JUNK SPENDING! How else are things EVER GOING TO CHANGE?? Collapse as in Greece!! Coming our way by 2016 or SOONER!

Taxes as a % of GDP are significantly lower here, due to a massive amount of deductions and loopholes that don't exist in Europe. I'm talking deductions for mortgage interest, charitable contributions, homestead/old people (state/local property tax), company-sponsored health insurance, 401-k contributions which many people "borrow" from way before retirement. Also Medicare/caid pay out a LOT more on a per patient-year basis than the European healthcare systems. Finally, the U.S. has more layers of government and taxing entities - federal, state, cunty, city, school district, transportation district which are usually federations of counties - which inevitably generates redundancy and waste due to less-than-optimal collaboration.

Anyway, I agree with the Republicans that the right way to approach this is to keep tax RATES flat - it's fairer especially for young people, entrepreneurs, renters, etc. and I believe it really does encourage people to work and study harder and be more ambitious - and to take big chops at deductions and wasteful spending like farm subsidies and overissuance of food stamps (does 15% of America really need their FOOD paid for by the rest?!).

Problem is that even Republicans don't want to touch third-rail topics like the mortgage interest deduction, deduction for company-paid healthcare premiums which are both massively beneficial to large parts of the middle class at the expense of the whole, and payment of Social Security benefits to many who are well off already. As StrayObject says defense is HUMONGOUS at $900b. Obviously we can't cut all of it but still...it was $500b in 2000 (inflation-adjusted) for Christ's sake! I know of projects myself where the military tech is way behind current civilian tech, yet the military "needs" to spend huge amounts of money customizing a prior-generation technology.